In Siemens USA Holdings Inc. v. Geisenberger, No. 20-2991 (3d Cir. 2021), the Third Circuit found that the District Court erred (1) in holding that Siemens’ preemption claim was unripe, and (2) in denying Siemens’ motion for a preliminary injunction. Both the question of ripeness and the injunction request related to whether the escheat priority rules preempted certain audit procedures, as opposed to the validity of an assessment. Specifically, Siemens brought the lawsuit claiming, among other items, that Delaware’s audit requests for records with addresses outside of Delaware were preempted by the priority rules.
Stepping back to review the framework used by the Third Circuit, the court followed the Supreme Court’s line of cases dubbed the “Texas Trilogy,” which established an order of priority among the states competing to escheat abandoned intangible personal property. In short, these priority rules allow first priority to the state of the property owner’s last-known address, and if the last-known address is unknown or in a state that does not provide for escheat, then second priority is to the state where the property holder is domiciled. The second priority rule is significant for Delaware given the number of companies incorporated or formed there.
Under Delaware’s unclaimed property audit procedure, the state uses estimation methods to determine unclaimed property liability for audit periods where the holder does not have records. These estimation methods often look to a test period where records are available to develop an error ratio, and then project the error ratio over the audit periods where records are not available. The state’s position is, for companies incorporated or formed in Delaware, all unclaimed property must be included in the error ratio because, for any periods where there are no records, all unclaimed property is escheatable to Delaware under the second priority rule because the last-known address must be unknown. While the policy framework for this position is beyond scope here, it is noted that this position is antithetical to returning the property to its owner and has been found in Temple-Inland, Inc. v. Cook, Civ. No. 14-654-GMS (D. Del. June 28, 2016) to create “significantly misleading results” and to violate substantive due process.
Returning to the Siemens case, over the course of a decade-long audit, the state was requesting records going back 19 years, a portion for which Siemens did not have complete records. For estimation purposes, as noted above, Delaware sought to discover all unclaimed property for the test period; however, under the priority rules, Siemens refused to offer records related to unclaimed property with a last-known address in a state other than Delaware. Siemens’ refusal did not deter the auditors, so Siemens brought an action seeking federal preemption over the records requests under the priority rules and a preliminary injunction to stop further requests.
The District Court dismissed the federal preemption as unripe since the audit had not concluded. The Third Circuit, however, reviewed the federal preemption challenge as a challenge to the scope of the audit, and therefore held that the challenge was ripe.
For the preliminary injunction request, the District Court held that Siemens failed to show that it would suffer irreparable injury absent an injunction. In reviewing this holding, the Third Circuit found that the District Court misinterpreted its precedent because the running of interest and penalties during the course of an extended audit may rise to the level of irreparable injury, including the possibility that the threat of penalties in and of itself could constitute irreparable injury. Siemens also raised certain constitutional objections to the Delaware audit, but they were generally dismissed by the District Court and the dismissal was affirmed by the Third Circuit.
The Third Circuit remanded the case for further proceedings consistent with its holdings on ripeness and the preliminary injunction precedent. In doing so, the court opined on a component of the second priority rule:
[W]e reject an interpretation foreclosing the state of corporate domicile from claiming priority simply because the state of the creditor’s last known address has an escheat regime, regardless of whether that regime would take the property type at issue. We instead read the Texas trilogy to state that, even if the state of the creditor’s last known address has an escheat regime, if it does not provide for escheat of the specific property type at issue, then the state of corporate domicile can still claim priority if its broader escheat laws do provide for escheat of that specific property type.
This interpretation of the second priority rule nullifies specific escheat exemptions for holders that are domiciled in a state other than the state with the exemption. For example, several states exempt gift cards from escheat. Companies domiciled in a state where gift cards are not exempt and that hold gift cards with a last-known address in a state that exempts gift cards may need to escheat such property to their state of domicile under the Third Circuit’s interpretation of the second priority rule. Such an interpretation may be counter to federalism, allowing one state to reverse policy decisions of another state, and is also inconsistent with how many states have enforced their unclaimed property laws.
While Delaware is statutorily barred from pursuing property that is “specifically exempt” from a first priority state’s escheat regime, the Third Circuit’s interpretation may embolden auditors and leaves room for property types that are not specifically exempt under the laws of the first priority state. Thus, while the Siemens case is a partial holder victory in response to Delaware’s aggressive unclaimed property audit tactics, it remains to be seen whether the decision may impact how Delaware and other states view property that is exempt under, or not covered by, another state’s unclaimed property regime.